Navigating Benefits

The Advantages and Disadvantages of Offering a Pension Plan

  • As of 2017, only 10 percent of American workers have access to a traditional pension plan benefit

  • Pension plans place more burden on employers, while 401(k)s require greater employee participation

  • Some large companies are returning to pension plans as the GOP may reduce retirement savings limits

Posted by January 8, 2018

For generations, the pension plan was the standard when it came to retirement benefits offered to workers. This defined benefit provided additional financial security upon retirement for loyal employees who worked the required number of years.

Unfortunately, many younger employees will never get to experience a pension plan, as this benefit is quickly disappearing from many industries and being replaced by retirement savings plans. Additionally, The Washington Post reports that the current Republican administration under President Trump is undergoing talks to reform the tax laws around retirement plans, placing limits on what workers can save each year.

If your company still offers pension plans to employees, what are the advantages and disadvantages? Further, how do these plans compare to retirement savings plans available today? In order to remain competitive in the war for talent, it is critical that your organization offers the best benefits.

The Benefits (and Problems) With Pension Plans

The pension plan—a defined benefit—was designed to offer a guaranteed payout to eligible retirees and their spouses based on a formula that calculates years of service and salary earned. The idea is that the longer someone works, the more they will earn, resulting in a higher automatic monthly payout.

Interestingly, the current Social Security retirement benefit is based on the pension plan model. With reversals to health care reform also in the works, several large companies have begun to boost funds for their pension plans in an effort to help workers cover their future health costs.

Pensions are designed to reward loyal employees, and these plans have worked well for most industries. However, pension plans are fizzling out, according to data from a Pew Charitable Trusts report released in early 2017. Just 10 percent of workers over the age of 22 have traditional pensions. Only 6 percent of millennial workers (and 13 percent of baby boomers) have a pension plan.

Pension members and employers have complained about the administration of these plans, including the costs to maintain them. Others have argued that pension plans do not provide enough financial means when a worker retires because it’s limited by past earnings, and doesn’t take into consideration future cost of living adjustments and inflation. This is why other retirement savings plans—like IRAs and 401(k)s (defined contribution)—were developed to give individuals more opportunities to save up money for retirement.

Comparing Pension Plans to Other Retirement Savings Benefits

Both pensions and individual retirement savings options are beneficial for employees because they provide a way for working Americans to create the kind of retirement lifestyle they desire. Employees can earn more and increase their pension plan payouts, or they can put more money into a retirement savings plan that acts as a tax shelter. In both cases, employers are contributing a large share of the funds.

A defined benefit, however, puts most of the financial and administrative burden on the organization at the time that each employee retires. The retirement age can vary, as some plans allow younger employees to collect a portion of their benefits. According to the Social Security Administration, around 46 percent of all pension plans have been underfunded since the 2008 recession—meaning there are deficits that must be repaid.

A defined contribution, like a 401(k), puts the burden on both the employer and employee over time. These funds are treated as tax-deferred until the employee retires. In the case of traditional pension plans, the employer benefits from the tax-break; with a 401(k), it’s more beneficial for the participating employee, from a tax standpoint.

Improving Retirement Benefit Plan Participation and Talent Retention

The overall problem with all retirement savings plans and pensions comes down to the amount of income that employees can set aside from take-home earnings. Until wages catch up to inflation rates and housing costs in many regions, plan participation will likely remain low.

Employers must decide how they can best help their employees plan for retirement, so the choice is ultimately dependent on each employer’s preference. By using alternative financial incentives, improving group health care benefit offerings and providing competitive salaries, employers can effectively compete for talent and retain workers. Only then will employees be able to focus on what they need to do in order to retire comfortably.

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